What Happens When You Reach the Required Minimum Distribution Age?

When you turn 70 ½ you reach the required minimum distribution age. That means you must take a certain amount out of your IRA and most other retirement accounts as well.  These are known as RMDs – Required Minimum Distributions.

That’s right. Even if you don’t need or want the money, you must take out a minimum amount or the IRS will become rather upset with you. You don’t want that.  They will slap you silly with stiff penalties.  More on that shortly.

Let’s look at the mechanics of what happens once you turn age 70 ½. We’ll do this by examining a made up person – Kate. She turned 70 in January and she has IRA money invested in various brokerage firms.

1. Notifications

Since Kate turned 70 in January, that means she will turn 70 ½ in July. As a result, she should receive a letter from every IRA custodian she currently uses. They will inform her that she should take out her RMD before 12/31 of this year. She should get that letter no later than 1/31.  Then she’ll fill out a distribution form and send it in.  Once the custodian process the request, Kate will get her money.

Neal’s Notes – Please don’t rely on your custodian or financial advisor to inform you about your RMDs. While it is the professional thing to do, many fail to do so. Also, many custodians calculate the RMD incorrectly. This is especially true when it comes to Beneficiary IRA RMDs. You would not believe how many custodians and CPAs I see blow it. Sometimes I can’t believe it myself. Make sure to double check the calculations.

2. When is the real deadline to take the money?

While everyone encourages Kate to take the money by 12/31 of this year, she really doesn’t have to take it until April 1st of the following year. This is because the IRS thinks that once people turn 70 ½ they start forgetting things. As a result, they provide a little leeway for the first time RMD. (I started forgetting things when I turned 30 – I wonder if I can get a special IRS ruling….)

Most people don’t “take advantage” of this delay because if they do, they have to take out a double amount the following year. My suggestion is just to take an RMD every year once you turn 70 ½ as long as you have retirement assets. So Kate will have an RMD for this year and next year and every year thereafter until she exhausts the assets. If she forgets to take this year’s amount, she can take it next year (by April 1st) as I said.   But she’ll still have to take out next year’s RMD too. Of course she’ll have until 12/31 of next year to take next year’s RMD.

3. What happens if Kate doesn’t take out the RMD?

Nothing – if you consider a 50% penalty nothing. That’s right. The IRS will penalize Kate 50% for the amount she fails to withdraw. The IRS might waive the penalty if she proves that her failure was because of a reasonable error and that she’s corrected it. Still, do you think Kate really wants to depend on the loving kindness of the IRS? I don’t think so.

4. Who calculates the amount?

Kate has four choices here. First, she can ask her CPA or tax preparer to do the calculation. Second she can ask her financial advisor. And third, she can ask her IRA custodian. If she is a real hands-on person, she can calculate the amount herself by reading IRS publication 590

(Most people calculate the RMD amount based on the IRS Uniform Lifetime Table. But if your spouse is the only beneficiary of your IRA and he or she is more than 10 years your junior, you can use the IRS Joint Life Expectancy Table instead.)

5. Are all Kate’s plans subject to the RMD?

If Kate has IRA’s all over town and she must take RMD’s for all of these accounts – but not from each of the accounts. In other words, if she has 2 accounts worth $100,000 each and her RMD is $4700 each or $9400 total, the IRS doesn’t care how she takes the money as long as she does take all of it. She might take the entire $9400 from one IRA and leave the other intact or she might take the money in proportion to the account size or any arrangement in between.

She must also take an RMD from all her employer sponsored plans including profit-sharing plans, 401(k)s, 403(b)s, and 457 plans (if she is separated from service). She must also take an RMD from SEPS, SARSEPS and SIMPLE IRAs.

6. Can Kate take out more than the RMD?

Yes. She can take up to 100% of the account value – and pay tax on it of course.

7. How are RMDs taxed?

As ordinary income. Ouch.

In conclusion

When you reach 70 1/2 you only have to take a few easy steps:

a. Think about the year in which you will reach 70 ½.
b. Get the account values for all your retirement accounts as 12/31 in the before you reached 70 ½. (You only need to do this if you calculate the RMD yourself or ask your tax preparer to do it for you.)
c. Calculate the RMD yourself or contact each of the IRA custodians and ask them to calculate your RMD for you.
d. Submit paperwork to the custodian to satisfy your RMD requirement.

Have you already started taking your RMD’s? What was the process like? Were any mistakes made?